Horizon Technology Finance Corporation (NASDAQ:HRZN) Q4 2023 Earnings Call Transcript February 28, 2024
Horizon Technology Finance Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Greetings, and welcome to the Horizon Technology Finance Corporation’s Fourth Quarter 2023 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Megan Bacon, Director of IR.
Megan Bacon: Thank you, and welcome to Horizon Technology Finance Corporation’s fourth quarter 2023 conference call. Representing the company today are Rob Pomeroy, Chairman and Chief Executive Officer; Jerry Michaud, President; Dan Devorsetz, Chief Operating Officer and Chief Investment Officer; and Dan Trolio, Chief Financial Officer. I would like to point out that the Q4 earnings press release and Form 10-K are available on the company’s website at horizontechfinance.com. . Before we begin our formal remarks, I need to remind everyone that during this conference call, the company will make certain forward-looking statements, including statements with regard to the future performance of the company. Words such as believes, expects, anticipates, intends or similar expressions are used to identify forward-looking statements.
These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ on a material basis from those projected in these forward-looking statements. And some of these factors are detailed in the risk factor discussion in the company’s filings with the Securities and Exchange Commission, including the company’s Form 10-K for the year ended December 31, 2023. The company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. At this time, I would like to turn the call over to Rob Pomeroy.
Rob Pomeroy: Welcome, everyone, and thank you for your interest in Horizon. Today, I will update you on our performance and our current overall operating environment. Dan Devorsetz, our Chief Operating Officer and Chief Investment Officer, will then take us through recent business and portfolio developments. We welcome Dan to the call, and he will now be a regular participant on our future calls. . Jerry will then discuss the overall venture lending market, and Dan Trolio will detail our operating performance and financial condition. We will then take some questions. 2023 was a challenging year for participants in the venture debt market, including Horizon. While we were able to finish the quarter and year with our net investment income, again, exceeding our quarterly and annual distributions as well as achieving record NII for the year.
Our net asset value declined due to the underperformance of certain stressed investments in our portfolio. The stress in the venture capital ecosystem, including the collapse of Silicon Valley Bank, the tightening of capital availability, the closed IPO markets and the decline in valuations contributed to the unfavorable performance by some of our portfolio companies, resulting in the reduction of the fair values of our investments in such portfolio companies. You’ll hear this theme throughout our call, but we continue to work diligently to maximize the value of all of our investments, including where necessary, from the sale of our portfolio of companies or our collateral. Recapping our full year 2023 results, we generated net investment income of $1.98 per share, well in excess of our declared distribution level for the year due largely to higher interest rates on our floating rate debt investment portfolio and lower incentive fees earned by our advisor.
Based on our strong NII performance and the confidence in our outlook, in 2023, we paid regular distributions of $1.32 per share and a $0.05 per share special distribution. Our December special distribution marked the fourth consecutive year we paid such a distribution. We achieved a portfolio yield of more than 16% on our debt investments for the full year, once again, at or near the top of the BDC industry. We finished the year with a committed and approved backlog of $218 million. We ended the year with a net asset value of $9.71 per share, primarily the result of fair value markdowns of our investments. We supported our balance sheet during the year, raising equity from an overnight equity offering in June and raising over $26 million of equity at a premium to NAV from our at-the-market program.
We also expanded the capacity of our credit facilities with New York Life and KeyBank. And importantly, our adviser, Horizon Technology Finance Management completed its sale to Monroe Capital, now providing our adviser with access to Monroe’s platform and resources, which we expect to benefit Horizon through increasing access and capability to originate quality venture debt investments. We were pleased to complete our first co-investment with Monroe in December with the origination of a loan to VERO Biotech. Finally, based on our outlook and our undistributed spillover income of $1.25 per share as of year-end, last week, our Board declared monthly distributions of $0.11 per share payable through June of 2024 together with a special distribution of $0.05 per share payable in April.
Entering 2024, we continue to actively manage all of our investments while we support our borrowers and seek to maximize capital recovery in a difficult venture market. Looking ahead, we will remain prudent with respect to growing Horizon’s portfolio of debt investments while we work to maximize our NAV. With that, I will now turn the call over to Dan Devorsetz to give you more details and color on our performance. Dan?
Dan Devorsetz: Thanks, Rob, and good morning to everyone. I’m happy to join today’s call and look forward to speaking to you all in the quarters to come. Our portfolio size is slightly down in the fourth quarter from the prior quarter at $709 million, as new originations in the quarter were offset by prepayments and normal portfolio amortization as well as portfolio markdowns. In the fourth quarter, we funded six investments totaling $63 million including debt investments to three new portfolio companies and three existing portfolio companies. This combination is a reflection of our long-term portfolio strategy of lending high-quality venture loans to new borrowers with additional financing to existing borrowers that achieve important operational and financial milestones.
While we maintain a healthy pipeline of new opportunities, we expect to remain selective in new originations for the near term and we expect the potential growth in the portfolio to occur towards the middle and back half of the year. During the quarter, we experienced three loan prepayments and one partial paydown totaling $48 million in prepaid principal. Similar to past years, we expect modest prepayments in the first quarter of 2024 with this normal seasonal trend compounded by the weak IPO and M&A markets at the end of 2023 continuing in the first month of 2024. Our onboarding yield of 13.8% during the fourth quarter remained near our historic highs, reflecting the ability of our team to source and structure new quality venture loans even in this challenging environment.
We expect our discipline in structuring and pricing transactions to continue to produce strong net investment income. Our debt portfolio yield of 16.8% for the quarter and 16.6% for the full year was again one of the highest yielding debt portfolios in the BDC industry. This further validates the profitability of our venture lending strategy and our execution of debt strategy in an elevated interest rate environment. As of December 31, we held warrant and equity positions in 99 portfolio companies with a fair value of $32 million. As a reminder, in addition to the high debt investment yield I just spoke about, structuring investments with warrants and equity rights is a key component of our venture debt strategy and a potential generator of shareholder value.
In the fourth quarter, we closed $124 million in new loan commitments and approvals and ended the quarter with a committed and approved backlog of $218 million compared to $202 million at the end of the third quarter. We believe our committed backlog with most of our funding commitment is subject to our portfolio companies, achieving certain key milestones provides solid base as we look forward to prudently grow our portfolio during the course of the year. As of year-end, 90% of the fair value of our debt portfolio consisted of three and four rated debt investments compared to 87% as of September 30 and 10% of the fair value of our portfolio was rated two or one compared to 13% as of September 30. For our stress investments, we are continuing to diligently work for innovative solutions that can enable us to achieve additional recoveries.
As Rob noted earlier, we continue to work closely and collaboratively with all of our current portfolio companies, their management teams, investors and stakeholders to navigate the continued uncertain venture macro environment. While doing so, we remain just as focused on sourcing and originating new debt investments in order to take advantage of market opportunities to make venture loans, the companies whose investors have increased their support at attractive valuations while we also benefit from the current interest rate environment. With that, I’ll turn it over to Jerry for a look at that overall venture industry and current environment.
Jerry Michaud: Thank you very much, Dan. Turning now to the venture capital environment. According to PitchBook, approximately $171 billion was invested in VC-backed companies in 2023, the lowest total in four years, reflecting the ongoing market issues related to valuations and investors being inwardly focused on managing our existing portfolio investments. VC investment activity levels remain depressed in Q4 as venture capital investments from 2021 and in the first half of 2022, continued to face devaluation issues and stress liquidity levels during 2023. VC funds that did raise capital during that time have maintained significant dry powder commitments, and we expect there will be pressure and opportunities in 2024 for VC funds to invest their LPs committed capital.
We have witnessed many private company valuations dropped steadily over the last six quarters, and there are some evidence that private company valuations are becoming more attractive again to both VC investors as well as strategic buyers. While we expect VC activity to gradually and steadily improve in 2024, certain market segments such as AI solutions-driven companies and life science companies should see significant investor interest in 2024. Of course, any improvement in the venture capital environment in 2024 will require the macroeconomic environment to continue to improve, including a reduction in overall inflation and interest rates during 2024. In terms of VC fundraising, only $67 billion was raised in 2023, the lowest in six years as the avenue to public exits remained largely closed in 2023.
VC’s committed capital from their LPEs remained at record highs as a result of amounts raised during 2021 and 2022. VCs will remain reluctant to make new investments in the current market until exit markets improve and the significant correction in private company valuations subsides. We expect VC’s fundraising to lag VC investment in 2024 as the LP community remains largely on the sidelines until they begin to see attractive VC portfolio exits become more frequent. VCs will have high hurdles for raising new funds based on recent returns, quality of portfolios, organization size and investment strategy. Meanwhile, VC-backed exit activity hit a decade low in 2023 as a modest market rally in the fourth quarter was not enough to fully open up the IPO market.
The M&A market for venture-backed companies remained at historic lows as a combination of unrealistic valuations and higher interest rates, combined with regulatory scrutiny continue to keep acquirers on the sidelines. We believe 2024 valuations will begin to become more attractive – because of six quarters of declining values. We believe industries such as energy, technology and healthcare are best positioned to resume M&A activity given the historically high earning results, public stock prices posting strong gains and the elevated level of cash and liquidity on the balance sheets of technology, big pharma and energy companies. In terms of market conditions for new venture loan investments, we expect the challenging environment of 2023 to moderate in the first half of 2024.
So we should see a gradual increase in demand for venture debt during 2024. And we hope to see, as Dan indicated, an increase in our originations as the year progresses. Accordingly, we will stay on current course of thoughtfully adding select top quality investment opportunities to our portfolio during this period while focusing on preserving and improving our current portfolio’s value and credit quality. As market conditions improve over time, we continue to believe Horizon’s solid reputation and long-term market presence will allow it to prudently accelerate its portfolio growth. A key baseline for future prudent portfolio growth is our committed, approved and awarded backlog, which as of today, stands at $188 million, and our advisers pipeline of new opportunities, which as of today stands at $743 million.
To sum it up, it was a challenging 2023 for venture lending and venture investing, and we look forward to improving conditions for both our industry and our portfolio as we move through 2024. We will remain laser focused on credit quality and providing all of our portfolio companies with support to ensure optimal outcomes. Where we find attractive companies seeking ventures debt solutions, we will add to our pipeline and backlog as we look to begin to prudently accelerate portfolio growth during 2024. Based on our current portfolio size and attractive yield, we believe we remain well positioned to continue to generate solid NII for our shareholders and build additional long-term shareholder value. With that, I will now turn the call over to Dan Trolio.
Dan Trolio: Thanks, Jerry, and good morning, everyone. We had a strong year from an NII standpoint, once again, generating NII that more than covered our distribution while actively strengthening our balance sheet throughout the year. In addition, we continue to diligently work with all of our companies in order to optimize outcomes for our portfolio and further enhance our credit quality. To recap 2023, our portfolio stood at $709 million. In May, we expanded the capacity of our New York Life credit facility by $50 million to $250 million. In June, we successfully raised nearly $39 million in net proceeds from our common stock offering, further strengthened our balance sheet in June by increasing the commitment amount on our KeyBank facility to $150 million and by expanding as according feature to $300 million.
So at the end of the year, we fully paid off our 2019 securitization. Finally, we successfully and accretively sold over 2.2 million shares to our ATM program during the year, raising over $26 million, further demonstrating our continued ability to opportunistically access the equity market. As a result, we believe we remain well positioned to add quality investments to our portfolio and create additional value for shareholders in 2024. As of December 31, we had $104 million in available liquidity, consisting of $73 million in cash and $31 million in funds available to be drawn under our existing credit facility. We currently have $70 million outstanding under our $150 million KeyBank credit facility and $181 million outstanding on our $250 million New York Life credit facility, giving us with ample capacity to grow the portfolio.
Our debt-to-equity ratio stood at 1.4:1 as of December 31 and netting out cash and our balance sheet, our leverage was 1.2:1 which was within our target leverage. Based on our cash position and our borrowing capacity on our credit facilities, our potential new investment capacity at December 31 was $222 million. For the fourth quarter, we earned investment income of $28 million, an increase of 22% compared to the prior year period. Interest income on investments increased primarily as a result of the higher average size of our debt investment portfolio and increases in the variable interest rates on our debt investment. Our portfolio investment on a net cost basis to $721 million as of December 31, a 1% increase from September 30, 2023. For the fourth quarter of ’23, we achieved onboarding yields of 13.8% compared to 13.9% achieved in the third quarter.
Our loan portfolio yield was 16.8% for the fourth quarter compared to 14.5% for last year’s fourth quarter. Total expenses for the quarter were $12.2 million compared to $12 million in the fourth quarter of ’22. Our interest expense increased to $7.6 million from $6.2 million in last year’s fourth quarter due to an increase in the average borrowings and higher interest rates on our borrowing. Base management fee was $3.2 million, up from $3 million in last year’s fourth quarter due to an increase in the average size of our portfolio. We had no performance-based incentive fee in the fourth quarter compared to an incentive fee of $1.4 million for last year’s fourth quarter. This was due to the deferral of incentive fees otherwise earned by our adviser in the quarter under our incentive fee cap and deferral mechanism.
The deferral was driven by unrealized and realized losses on the portfolio. As 2024 progresses, we would expect deferrals to end and once again pay our adviser incentive fees. Net investment income for the fourth quarter of 2023 was $0.45 per share compared to $0.53 per share in the third quarter of 2023 and to $0.40 per share for the fourth quarter of ’22. For the full year 2023, we generated NII of $1.98 per share, more than covering our total distributions during 2023 $1.37 per share. company’s undistributed spillover income as of December 31 was $1.25 per share. We anticipate that the size of our portfolio, along with the portfolio’s elevated interest rates and our predictive pricing strategy will enable us to continue generating NII that covers our distribution over time.
As a reminder, the first quarter is typically the lightest in terms of prepayment activity, and we expect the first quarter of 2024 to be in line with the lower historic norm. To summarize our portfolio activities for the fourth quarter, new originations totaled $63 million, which were offset by $13 million in scheduled principal payments and $48 million in principal prepayments and partial pay down. We ended the year with a total investment portfolio of $709 million. Given the macro environment, we expect to remain selective in the near term with respect to originations. At December 31, the portfolio consisted of debt investments in 56 companies with an aggregate fair value of $670 million and a portfolio of warrant, equity and other investments in 102 companies with an aggregate fair value of $39 million.
Based upon our outlook, our Board declared monthly distributions of $0.11 per share for April, May and June 2024 and given our amount of spillover income, our Board also declared a special distribution of $0.05 per share payable in April. We remain committed to providing our shareholders with distributions that are covered by our net investment income over time. Our NAV as of December 31 was $9.71 per share compared to $10.41 as of September 30, 2023, and $11.47 as of December 31, 2022. The $0.70 reduction on NAV on a quarterly basis was primarily due to paid distributions, including the $0.05 per share special distribution, realized losses and adjustments to fair value partially offset by net investment income. As we’ve consistently noted, nearly 100% of our outstanding principal amount of our debt investments, fair interest and floating rates with coupons that are structured to increase if interest rates rise with interest rate floors.
This concludes our opening remarks. We’ll be happy to take questions you may have at this time.
Operator: [Operator Instructions] And our first question comes from the line of Bryce Rowe with B. Riley Securities. Please proceed.
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